Bundling refers to selling, in a single transaction, two or more items that could be sold separately.
While likely an exaggeration but definitely not too far away from the truth, Jim Barksdale, former CEO and President of Netscape, said:
There are only two ways to make money in business: one is to bundle, the other is unbundle
Bundling often comes with a negative connotation. Think cable. Aren’t we restricting choices? Why should one pay for access to channels which one would never watch?
In fact, a lot of businesses are based on the core idea of unbundling products and services. Let’s consider fintech. Fintech is, essentially, disintermediating (unbundling) traditional financial services providers, while improving the product quality and user experience.
Source: CB Insights
However, bundling makes tremendous economic sense in a lot of industries/products, and is probably one of the few things that can potentially benefit both producers and consumers.
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A simplified explanation of how bundling works
Imagine two friends, A and B, who go to McDonalds. A loves burgers, and likes fries as well, though not as much as burgers. B has the opposite set of preferences.
Here’s the ‘Willingness to Pay’ (WTP) for these products by each consumer:
Now, the optimum price to be charged by the producer in order to maximize revenues is always somewhat lower than the WTP of customers. For the sake of simplicity, let’s assume that the optimum price is equal to 90% of the WTP. Hence, McD would price the burger and fries both at Rs.90 each, sell to A and B respectively, and earn a total revenue of Rs.180. The total consumer surplus (WTP – price), in this case, would be Rs.20.
But, if McD decides to bundle the two goods, then it could offer the combination at Rs.135 (90% of Rs.150) and earn Rs.270. Further, the consumers would also benefit – the total consumer surplus in this case would be Rs.30.
The problem with selling individual products is that the demand for each product can be highly variable and sometimes, inversely correlated as reflected in the example above. As such, the company is forced to price the product high to sell to a few customers or to reduce prices drastically to sell to a larger base. However, aggregating the two demand curves by bundling them makes overall demand much less variable, thereby flattening the demand curve. While different people are willing to pay starkly different prices for the two products, a combination of the two products results in much less variability in willingness to pay. Lesser the variance, easier it is to charge a price that ‘works for everyone’ and hence, enables capturing a larger part of the demand.
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How bundling helps in creating value
To understand bundling in a more practical way, Shishir Mehrotra (founder of Coda) suggests dividing the customer universe into three categories (1).
1. Super Fan: This is someone who fits two criteria:
They would pay the a-la-carte price for the channel. This means that they are fairly far along the price elasticity curve for the good (perhaps to the inelastic point)
They have the activation energy to seek out the good and purchase it
2. Casual Fan: Someone who would value the good if they had access to it, but lack one of the two Super fan criteria ー either they aren’t willing to pay the a-la-carte price for the good, or don’t have the activation energy to seek it out, or both
3. Non Fan: Someone who will ascribe zero (or perhaps negative) value to having access to the good.
Now, as we discussed in the example above, if a company decides to offer its goods only a-la-carte (that is, not as part of any bundle), it would only be able to service the Super Fans (since their WTP is equal to or higher than the price). The Company ends up losing out on all the Casual Fans (who still exhibit demand for the product, just not as much as the Super Fans). Put another way, in case someone needs access to a product, they need to be a Super Fan.
This is the heart of how bundles create value ー it’s not about addressing the Super Fan, it’s about allowing the Casual Fan to participate
One of the best examples to see this in action is the music industry. People feared that once steaming companies like Spotify, Amazon Music etc came into picture, the overall music industry revenues would go down (Reason: Rather than paying USD 10 or so for a single album, people can pay USD 10 to listen to all songs). However, have a look at what happened with the music industry’s revenues:
Source: Bloomberg, RIAA
To summarize, for producers, bundling creates efficiencies in the form of customer acquisition and product / service distribution while increasing the addressable base. For consumers, apart from lower aggregate prices, bundling reduces search costs.
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Some interesting aspects of bundling:
Aspect 1: What is the best way to design bundles?
Intuitively, one would feel that bundling makes the most sense when the products offered are similar – for example, Hotstar bundles movies and shows, Spotify bundles songs and podcasts and so on. This makes it easier for customers to ‘value’ the bundle.
Shishir, in his writings, provides a counter-intuitive way to think about bundles. He says that the best bundle is the one that minimizes Super Fan overlap and maximizes Casual Fan overlap. What this would mean is that products being bundled can be quite unrelated, as long as the overlap of casual fans is maximized.
If we look around, we do have some bundles of unrelated goods / services. Amazon Prime is one example - bundling free / early delivery with video content and music and a bunch of other stuff. I have written about it here.
Another example that I can think of (and which has been quite successful in India) is Unit Linked Insurance Plans (ULIPs). By bundling insurance and investments, this product category has managed to capture a very high share in the insurance market. My hypothesis is that there is a large set of people who would never buy insurance unless there is a return component attached to it (the category that term insurance providers cannot tap into) and similarly, there is a large set of people who would not want to invest in equity-linked instruments unless there is some protection element built in as well (the category that mutual funds cannot tap into). ULIPs, as a product, have managed to maximize the overlap of these casual fans of mutual funds and insurance respectively, and hence, have been successful.
The idea of maximizing casual fan overlap rather than focusing on super fans alone could lead to some interesting business models.
Aspect 2: Bundling benefits the bundler and the customer, but what about the bundlee (end-producer or service provider)?
This question came from the chart we saw above on the rise in music industry’s revenues because of streaming. It will be interesting to see how the value capture happens when the bundler (the entity providing the bundle) is different from the service provider (the entity manufacturing the good or providing the service which is being offered as part of the bundle). Essentially, what part of the revenue increase is captured by Spotify and what part is captured by artists / record labels.
One possible interpretation is that bundling makes the most sense for those service providers who do not have enough of a Super Fan customer base to be economically viable, and would need to be bundled with some other products to increase their target audience by enabling servicing of Casual Fans as well. Spotify may not be an excellent deal for an established, popular musician but may be a blessing for an up-and-coming artist.
The economics of each bundling exercise can lead to different outcomes for the three parties, but it does seem that standalone products which are not economically viable would do better if bundled together.
Aspect 3: When can bundling be harmful for consumers?
Bundling first attracted regulatory glare (from an anti-trust perspective) in late 1990s, when Microsoft bundled its browser ‘Internet Explorer’ with the Windows Operating System.
Consumers generally benefit from bundles due to higher consumer surplus, as we saw above. But sometimes, in the long run, bundling can reduce consumer welfare in case it is used to eliminate competition. An example of this would be a firm bundling a product over which it has a monopoly with a non-monopoly product.
The Ken recently posted a very interesting article on Jio, and showed how, with the aid of its strategic partnerships and investments, it now straddles the entire telecom and digital services stack. (2)
Source: The Ken
The product+service layer above is a huge bundle in itself, even without considering the partnerships:
Now, on the face of it, this does seem like a great deal for the customers. But owning the entire stack (while providing a bundled offering) means that competitors and potential competitors are going to have a very, very hard time.
Anti-trust laws majorly peg competition to consumer welfare as defined by price effects. If an action is leading to lower prices for consumers, it generally avoids anti-trust scrutiny. However, having a bundled offering straddling through the entire stack while also having control over the essential infrastructure could lead to potential anti-competitive concerns. Probably, apart from consumer welfare, bundles need to be looked at from the lens of impact on market structure.
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In times when un-bundling seems to be the mantra in order to ‘transfer the power of choice’ to the customers, I do feel that bundling sometimes ends up not getting its fair share of credit. Used properly, it can generate tremendous value for all parties in the value chain.
Some interesting reads
1. Agglomerators vs. Specialists (Nikhil Trivedi)
Nikhil provides and excellent and well-researched classification of venture capital firms, while listing out possible implications for the future of venture capital
2. SPAC Attack (John Luttig)
Special purpose Acquisition Companies have been in the news a lot recently. They offer an unconventional way to get listed on public bourses. John does a great job in explaining this concept in layman’s terms.
References
1. ‘Four myths of bundling’ by Shishir Mehrotra:
https://coda.io/@shishir/four-myths-of-bundling
2. ‘Jio is in the endgame now’ by The Ken
https://the-ken.com/the-nutgraf/jio-is-in-the-endgame-now/
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